CAIRO/DUBAI— Egypt's currency black market is under threat from two directions, as aid from wealthy Gulf states promises to ease a dollar shortage and an increasingly confident central bank engineers a gradual depreciation of the Egyptian pound.

Since the 2011 revolution ushered in three years of political and economic turmoil, a gap has opened up between the pound's official market rate and the weaker rate at which it trades in illicit money changing shops and back alleys.

The gap is a symbol of Egypt's economic weakness as it struggles to attract hard currency. Now, however, the pound is rising on the black market as traders anticipate fresh inflows of cash from Gulf Arabs who backed last year's military move to end Islamist rule. Gulf states have welcomed the election as president last week of former army chief Abdel Fattah el-Sissi.

Meanwhile, the central bank has been guiding the pound lower in the official market, apparently judging that the economy has stabilized enough for it to undertake this process without triggering an uncontrollable run on the currency.

The result, black market dealers and bank economists say, is that the gap between the two rates may vanish as early as the end of this year, making back-street trading all but superfluous. The spread was 2.7 percent on Wednesday, down from 4.7 percent last week and over 10 percent early last year.

“If there's more money coming in from the Gulf, there won't be a thing called the black market,” a middle-aged trader, dressed in a worn-out gray sweater and black trousers, said in a luggage shop in Cairo's crowded Ataba district where he conducts his illicit - and anonymous - currency business.

Simon Williams, chief Middle East economist for HSBC in Dubai, said he suspected Egyptian authorities believed the country could now afford to let the pound fall in the official market to levels which attract healthy supplies of dollars.

“It's a sign of confidence - they think they can loosen their grip now and return to a normal regime,” he said.

Black market

The pound is officially trading between banks at 7.15 to the dollar, some 15 percent weaker than it was near the end of 2012, when the central bank introduced an auction system for dollars in order to ration hard currency and protect its reserves.

Banks must trade dollars within ranges around the central bank's auction cut-off prices for interbank, commercial and retail transactions, giving authorities effective control over the official exchange rate.

However, monthly demand for dollars in Egypt is over half a billion dollars greater than the amount supplied by the official market, economists estimate. The black market has sprung up to satisfy this demand.

There are now expectations that aid and investment from the Gulf may shift the supply-demand balance in the black market considerably - expectations fuelled by Saudi Arabia's King Abdullah, who said on Tuesday that countries should hold an aid donors' conference for Egypt.

It is not clear how much money Egypt will get or when. But the statement was a fresh signal that three of the world's richest countries, Saudi Arabia, the United Arab Emirates and Kuwait, view stabilizing Egypt as a geopolitical imperative.

The three governments have already pledged at least $12 billion in aid - and delivered most of it - since the Egyptian army ousted president Mohamed Morsi of the Muslim Brotherhood, whom Gulf states viewed as an ideological arch-enemy, last July.

Similar or larger aid amounts are possible in coming months or years as the Gulf shores up Sissi. The Gulf is also encouraging its state-owned companies to make big investments in Egypt, in areas from housing to energy.

“The expectation is that Sissi will fix the country and will bring in investments,” said another Cairo black market trader, declining to be named because he did not want to attract the attention of authorities.

He and others said the pound was now trading at around 7.35 to the dollar, much stronger than its rate of 7.50 just last week, and lows of near 8.00 during Morsi's rule.

Official market

As long as Egypt's tourism industry and overall economy remain weak, Gulf money looks unlikely by itself to supply enough dollars to close the black market entirely.

The country posted a huge trade deficit of $15.4 billion between last July and December, and as tourism revenues were hit by security fears, its services surplus almost disappeared. Gulf aid received so far has halted a slide in the central bank's foreign reserves but has not boosted them significantly.

That is where central bank policy comes in. Since the end of March, when the official exchange rate was at 6.97, the central bank has been choosing cut-off prices in its dollar auctions that have had the effect of pushing the pound down very slowly.

This appears to be a major shift in policy - not confirmed by officials - since restoring currency stability was a priority and a major achievement for authorities after the pound's wild depreciation under Morsi. That alarmed investors and caused them to send hundreds of millions of dollars out of the country.

An informal Reuters survey of 10 traders, fund managers and economists in Egypt and abroad found eight of them predicting the pound's official rate would fall further by the end of this year, to an average rate of 7.35; that would mean a total depreciation of 5.4 percent during 2014. Further moderate depreciation is seen as possible next year.

So far, central bank officials have not commented publicly on the reasons for the policy change, and officials familiar with currency policy could not be reached for comment.

But many private economists think authorities have two goals in mind. One is to boost economic growth, a priority for Sissi to keep popular support, by stimulating exports; trade minister Mounir Fakhry Abdel Nour has said Egypt wants non-oil exports to rise 15 percent this year, after 11 percent in 2013.

Trade is unlikely to be the main motive for the policy change. Egypt's export sector accounts for only slightly more than 10 percent of the economy, and if a weak currency pushes up food price inflation, support for the government could suffer.

The main reason appears to be a desire to bring the pound down to a level which financial markets believe is good value, and therefore sustainable in the long run. That could persuade portfolio investors and companies from around the world, not just the Gulf, to resume putting money into Egypt.

Last year, Egypt's economy was so shaky that even starting a depreciation process could have triggered an uncontrollable market panic. Now, the market and the central bank, backed by Gulf aid, have more confidence that the process can be managed.

“They are managing a depreciation to encourage people into the market to bring in FDI [foreign direct investment],” said Allen Sandeep, research head at Cairo's Naeem Brokerage, adding that the level at which the pound eventually stabilized would depend on how quickly tourism revenues recovered.

If the black market does disappear and the central bank is able to end its dollar rationing system, returning to a relatively free market in which supply and demand balance, it would send a very positive signal to investors.

“Currency weakness will help exports, but normalization of the FX regime is more important than that,” said Williams at HSBC. “It shows the pound is convertible again, that the crisis is over and that Egypt is investable once again.”

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